Free Money! What Do I Do With It?

Free Money!

Maybe its money from a long lost relative. Maybe its a business deal or stock trade that went far better than planned, or maybe its a big tax return check or a bonus. We all LOVE getting money we weren’t expecting. I call that free money! Boy, the possibilities start to enter your mind on how to enjoy that money! I’m not talking about the dollar bill you found on the sidewalk or the five dollar bill folded up in a pocket. Those finds are sweet, don’t get me wrong, but I’m talking about some serious money that could afford something big, like a vacation, a new car or a whole lot of fun! If you’re like me, my head can get filled with ideas on how to use the money real quick. So years ago, when I was in one of these sweet situations, I had to stop for a moment and come up with an approach to dealing with large amounts of unexpected money so that I would make the best use of this new windfall. I call it the 30/50/10/10 plan. Here’s my approach:

Before We Get Started

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Before we get started let’s do two things: First, take a moment and list your overall financial goals and objectives. It helps to look at the big picture before we get into the details. For me that’s pretty simple: 1) Live in complete financial freedom, 2) Provide for my family, 3) Responsibly help in my community, 4) Pursue our passions. What does that look like practically?

  • No debt, no money worry or anxiety, no dependence on others for our needs
  • Ample savings for emergencies, retirement, family/house needs, and college expenses
  • Live on a balanced budget and teach our kids to do the same
  • Tithe to our local church plus support some local charities
  • Travel!

Second, before we use the free money, subtract an amount for taxes and (in our case) our tithe so that we know the real amount available for use. Typically, that totals about 30% of the free money. This is the 30 in the 30/50/10/10 plan, meaning the first 30% of the free money. In other words, if we received $10,000 of free money, we would put aside about $3,000 for taxes and tithe, ( giving thanks to God and giving Uncle Sam his portion), then plan to use the remaining $7,000. By doing this, we eliminate a nasty surprise come tax time at the next of the year when the money is all spent and we have nothing to pay the taxes with. Now we are ready to use the rest of the free money. But what do we do with it?

Step #1: Pay Yourself (The “50”)

Since financial freedom is our top priority, always, we need to pay ourselves first, in the form of eliminating debts and/or adding to our various savings and investments. At least half of all free money goes to paying ourselves first. This is the 50 (50% of the free money) in the 30/50/10/10 plan. First step: pay off any outstanding consumer debt. Is there a credit card with a balance still on it? Pay it off first. No questions asked. If there is no credit card balance but there is a car loan balance or a student loan balance, we make payments to pay down that debt. Next, if we paid down our debts and we still have some of that half left, we pay ourselves by adding to our savings and investments in this prioritized manner:

  • Top off our emergency fund, if it needs it, which when full, stands at three month’s worth of expenses
  • Extra savings for upcoming household needs: replacement used car, replacement washer and dryer, etc
  • Money towards the kid’s needs: College 529? Summer camp?
  • Add to long term investments
  • The retirement fund already gets maximum contributions from the budget so it gets a lower priority for any free money allocation.

Again, about half of the available free money goes to paying off any debts and/or savings, with the hope that we can achieve a milestone of some sort that we then can celebrate as a family.

Step #2: Celebrate!

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Celebrate! Take some of the free money and take time to celebrate 1) the free money and 2) the debt reduction and savings milestones you achieved in step #1. If the free money allows us to completely pay off credit card debt. Awesome! Let’s celebrate that. If the free money allows us to purchase, with cash, a good replacement washing machine because the old one died, great, let’s celebrate. If we can put some money away for that next vacation, celebrate! You get the idea. Most people don’t celebrate saving money or paying off debt, but most people will get excited about achieving a milestone. Take the family out to dinner, or go to a movie, or something that everyone gets excited about.

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Let your kids know what you are celebrating so they connect the fun with the milestone. The celebration doesn’t have to be big. Just big enough to make the point that the free money is an unexpected blessing that allows you to obtain or maintain your financial freedom as a family. The money to celebrate is a portion of the first 10 in the 30/50/10/10 free money distribution plan. In fact, step #2 and step #3 (explained next) combined make up the full 10%.

Step #3: Meet Family Needs

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Now’s a good time to put some money aside for upcoming family needs. These are things like kid’s school expenses, clothes, a delayed car repair or shoes. This money can also go toward a date night with your spouse or attending a special event. This money allows us to catch up on “want” expenses. Those purchases or experiences that make you feel special but don’t qualify as a “must have item”, like an emergency fund or putting money towards retirement. As mentioned in step #2, the combined total of money spent in steps #2 & #3 is not to exceed 10% of the free money.

Step #4: Be Prepared…And Generous (The Last 10)

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Want to really experience financial freedom? Try taking 10% of your free money, after you have tithed, paid Uncle Sam, saved, eliminated debt, celebrated and bought something special for that someone special, and set it aside…for what comes your way. That’s right, set aside money for living, and helping, in the moment. Do you have a friend that needs a little help? Maybe that friend just lost her job and you feel like you’d like to bring over some groceries. Use this money! Maybe you get an opportunity to help a local charity. Use this money. Maybe you’ve got wedding/birthday/Christmas presents you want to purchase, outside your regular budget. Use this money. Take 10% of your free money and set it aside as a contingency to help and/or bless others as you feel moved to do so. You may be surprised how freeing this money makes you feel, because it gives you the freedom to act in the moment. This is the final 10 in the 30/50/10/10 plan.

Financial Freedom Is Better

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Coming into free money, that is, a large amount of money that you did not expect to get, is wonderful in and of itself. But free money that is allocated in a way that supports your financial goals following financial freedom principles is even better. Why is that? Because the money is allocated consistent with your long term dreams and priorities. Let’s recap the free money allocation discussed here:

  • We gave thanks to God for the free money (Tithe)
  • We set aside a portion for taxes so that there would be no “gotcha” come tax time
  • We paid off debt
  • We saved and invested money for future needs, emergencies and dreams
  • We celebrated the blessing of the free money
  • We invested in some family  wants
  • We set aside money for opportunities that come our way

That is great use of money we never expected to get. It is invested in both our present and future needs that the whole family will benefit from. This distribution of free money is also generous, grateful and opportunistic, which goes a long way in our quest to live in financial freedom. What do you think of the 30/50/10/10 model? Let’s us know what you think! However you use your free money, I hope you achieve and maintain financial freedom.

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How Much Should I Be Saving? a.k.a. Prior Planning Prevents Poor Performance

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Knowing What To Do, And Doing It, Are Two Different Things

In January of this year, Fidelity Investments published a report that said we need to be saving at least 16% of our net spendable income (total income minus taxes and charitable giving). It went on to say that we really need to be saving closer to 23% of net spendable income if we want to be sure to have enough money to fund most of our dreams and plans. Yet, in that same article, Fidelity reported that the actual American savings rate is actually in a range between 4.5% to 7% of net spendable income. That’s right, Americans are saving roughly one third of what we should be saving. So what does that mean? Does it mean we only have 4.5-7% of our money left after paying our bills to go towards savings? Or maybe it means that we aren’t serious about the American dream, including retirement, travel and helping our kids with college. In any case, let’s take a look at what we should be saving for, how much we should be saving, and why it matters.

Categories Of Savings

Before we discuss the categories of savings, we should determine WHY we need to save. We save money from each paycheck to 1) build wealth to fund our lifestyle, dreams and goals, 2)self-insure against disaster, 3)  raise our families and 4) to help others through generosity. When there is enough savings to cover all four of these areas, we are well on our way to financial freedom. If that is the case, then there are four types of saving we need to maintain:

  1. Emergency Fund
  2. Retirement
  3. Family/Kids Savings
  4. Future Needs Savings

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Emergency Fund

First and foremost is an emergency fund. This is money set aside for true emergencies so that we don’t rely on debt when an emergency strikes. In fact, the emergency fund is the number one way to keep out of debt, as it is the most cost-effective self-insurance. How much emergency fund is enough?  Most pundits agree that somewhere between three months and six months of expenses is the right range for an emergency fund, depending on your risk adverseness. Once the emergency fund is fully funded, we do not need to continue to fund it. But every time we dip into the fund, we need to re-fill it to prepare for the next emergency.

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Retirement Savings

The second reason to save is for retirement. Let me say it another way. Once we have funded an appropriate emergency fund, we need to start saving for retirement, and the earlier we start the better because of the power of compound interest. There are many theories about how much and where you should save for retirement but the fact remains that we must prepare for life after full time work and/or old age. It is not our children’s responsibility to take care of us when we are old but our own. How much do we save? As a general rule, target 25 times your annual expenses as the amount you want to have for retirement. And though this amount varies for each individual, there are some smart rules to follow:

  1. Start saving for retirement early, letting compound interest work over decades of savings.
  2. Take advantage of tax preferred accounts like 401K, Roth, SEP and IRA accounts to minimize taxes
  3. Take advantage of employer matching plans and/or other employer retirement benefits

How much should we be putting away for retirement each month? Experts suggest we save 15% towards retirement.

images-3Family/Kids Savings

For those raising families or expecting to raise families, we need to be saving for known children expenses, including school, marriage, cars and other events (think summer camp and travel) that are assumed to occur. For most of us, this can be done over many years so slow and steady savings can meet your needs. Why not start savings accounts for each child on the day they are born? Where should we save this money? 529 Plans come to mind for their education. Also trust accounts or ESA’s. But they should be separate from our day-to-day funds and take advantage of tax preferred accounts if we know the money will be used for higher education. How much should we be saving each month? Experts suggest  3-5% of our pay.

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Future Needs Savings

Life happens and it can be expensive. All of us have autos, homes, furniture, appliances and other items that wear out or need upgrading over time. We need to be saving for these eventualities. Since these savings are short term in nature, less than 10 years, the money needs to be invested in something that is safe but returns more than the cost of inflation. Maybe a safe low cost, low turnover mutual fund or an ETF. How much each month? Again, 3-5% of pay.

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Total It All Up

Savings must be a part of the monthly family budget. Savings is as important as the rent, food and clothing. Why? Because savings, when invested correctly, generates the wealth needed to fulfill goals and dreams. Want to retire some day? Invested savings is the answer. Want to send your kids to college? Savings is the key. Want to stay out of debt? Saving, in the way of an emergency fund, is the only way to prevent credit card debt when (not if) an emergency occurs.

What are we looking at when it comes to savings as a percentage of net income? When you add it all up, it really is between 16-23% of our net pay. Wow! Some people even suggest it should be 30% of our net pay. That’s a lot. But it pales in comparison to the financial and mental cost of debt, worry and anguish that comes when “life happens” and we don’t have funds set aside to deal with the emergencies. Or don’t have the money when a car of some other piece of equipment wears out and we can’t replace it. What is the alternative? Credit card debt? Student debt? Auto loans? Line of credit? All of these option are expensive and ultimately steal away financial freedom.

Here’s the mindset we must have as stated by Warren Buffett: “We must spend what’s left after saving, not save what’s left after spending.” Instead of trying to save what’s left after spending, we need to make savings a priority and right-size our lifestyle to live comfortably on what’s left after saving.

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The Total Money Makeover: Classic Edition: A Proven Plan for Financial Fitness